Day: May 3, 2008

Half a Dozen Thoughts on Monetary Policy

Half a Dozen Thoughts on Monetary Policy

1) If you are looking for an article that describes how the Fed’s new lending facilities work, look here.? It shows the effects on the Fed’s balance sheet of each program.

2) Well, I guess the Fed is willing to further risk its balance sheet in order to force LIBOR down.? Now, this may have knocked 10 basis points off of the TED spread in the short run, but I am not sure what it will do long term.? It may do nothing, because the LIBOR lending markets are so much larger than the Fed.? As is noted in this piece:

Still, RBS Greenwich Capital chief economist Stephen Stanley cautions that adding AAA-rated asset-backed debt may not do the trick. ?This is not likely to be a major change, as the highest quality ABS were getting financed without too much difficulty already,? he wrote in commentary.

3) As I have noted before, the Fed cannot, and should not solve every lending problem.? There is a tendency for the financial system to adjust to monetary laxity and ask for more.?? This is just another aspect of the way our government operates, absorbing many medium-sized crises at the risk of an eventual run on the Dollar.

4) Should the Fed pay interest on reserves?? At present, the Fed has banks lend to each other through the interbank market; if the Fed paid interest, the Fed funds market could become an explicit market where banks loan money to the Fed, rather than to each other.? Now for the Fed to issue debt would allow them more flexibility in their balance sheet, but at a price.? We would have a central bank with additional liabilities beyond the currency, and that would have an impact on their ability to do monetary policy.

5) Funny how the Republicans grab for something unusual — pointing a finger at the Fed for commodity price inflation.? The Fed does have a small role there, but the bigger factor is the development of China, India, Brazil, and many other placesthat need raw materials in a way they did not previously.

6) Though I disagree with this paper, it is worth a read.? I am not a monetarist, I am more of an Austrian economist.? I acknowledge that economic systems are not stable, and that is a good thing in the intermediate-to-long run.? In my opinion, the main weakness of monetarism is that it fails to recognize asset inflation.? When the money supply is growing too rapidly, the money goes somewhere.? If savers predominate, it goes to assets, if spenders, to goods and services.? We mismeasure savings in the US — it is higher than commonly believed.? As such, growth in the money supply boosted asset prices.? But as the Baby Boomers gray, that balance will tilt as they draw on assets to finance consumption.

What is needed is a willingness for central bankers to stand in the way of investment/lending booms, and raise rates to deflate investment/lending bubbles before they deflate themselves, with large consequences to the economy.? That’s not coming anytime soon.

One Dozen Notes on Markets Around the World

One Dozen Notes on Markets Around the World

1) Desperation and the Dollar. In mid-March, pessimism over the US economy and monetary policy were so thick that people were considering the old Greenspanian rate of 1% Fed funds as possible. Well, times change, at least for now. The orange line above is the 2-year Treasury yield which gives a fair read on expectations of monetary policy, which bottomed in mid-March. It took the Dollar a little longer to move along, but the present course of dollar is up in the short-term (consider the Euro). That doesn’t address the possibilities of a wider lending problem, or the overly aggressive fiscal policies that will be employed by the next President. (Deficits don’t matter, until they are big enough to matter.)

2) I’ve talked about the US Dollar and the five stages of grieving. I think the G7 got to the second stage, anger, in threatening action recently. I think they get a respite from fear because of the bounce in US monetary expectations. My guess is that they would intervene when the Dollar gets to $1.70/Euro. Neither the threats nor the intervention will have much impact in the long run, though. This will only change when foreigners stop buying our bonds, and start buying our goods and services.

3) Another thing that correlates with the shift in expectations of US monetary policy are yields in long government bonds around the world. Surprise, as the anticipated future financing rates rise, the willingness to try to clip a spread off of long bonds declines.

4) So what could replace the Dollar as the global reserve currency? The Euro, maybe? The Yen and Pound are too small, and everything else is smaller still. The Yuan might be ready in 15 years when their financial markets are developed. It takes a long time for the reserve currency to shift.

5) So, why not the Euro? I’m still a skeptic that the EU will hang together without political union. Also, a strong Euro is testing the monetary union in places where credit markets are weak, and export markets are weakening because the US is getting more competitive with the weak Dollar. That said a persistently weak dollar raises the incentives for other countries to look for a new reserve currency. Leaving aside the potential instability of the EU (unlikely in the short run) the Euro is probably the best alternative.

6) This piece by Felix Salmon helps point out why why Iceland is the canary in the coal mine. They are the smallest economy with a floating currency. It seems like they are successfully defending their currency at present, at the cost of 15% interest rates.

7) Is the UK economy just a miniature version of the US economy?

8 ) Why is Chinese inflation rising? Loose monetary policy, and an undervalued Yuan, at least versus the Dollar. Now, maybe the Chinese will start buying Euro-denominated bonds, and sell more to the EU than they buy. (Note that I am not the only skeptic on the Euro’s survival.)

9) What of the Gulf States? What will they do with all of the dollars that they have? Along with China, their huge depreciating Dollar reserves are fueling inflation. Personally, if I were in their shoes, I would buy US corporations quietly, perhaps through the purchase of ETFs. But the huge accumulation of dollars threatens to create the same “white elephant” development schemes that they experienced in the early 80s, when the socialist Gulf governments had too many Dollars, and too few places to use them.

10) Inflation is rising in the OECD. This is a “sea change” in terms of economics. Policymakers have enjoyed falling inflation rates for so long that perhaps they aren’t ready for the degree of monetary tightening necessary to squeeze out inflation.

11) Development isn’t easy after a point. It reveals shortages, as India is experiencing in semi-skilled and skilled labor. This will eventually work out, but in the short run, it makes infrastructure and construction projects difficult. Bodies aren’t enough; skills are needed, and many better skilled Indians work abroad, where they can make more.

12) A rice cartel? Everything old is new again. I remember in the 1970s when the US talked about a wheat/corn cartel, in response to the new strength of OPEC. Personally, I don’t think it would be effective. Agriculture is too flexible for cartel-like schemes to work in the intermediate-term. But, let them try. It will be interesting to see what happens.

The Venn Diagram Method for Greatest Common Factors and Least Common Multiples

The Venn Diagram Method for Greatest Common Factors and Least Common Multiples

Uh, this is an off-topic piece. One of the benefits of working from home is that I can listen to my wife teaching our children, and every now and then, I drop in and explain some aspect of the topic further. Out of the corner of my ear, I heard my wife Ruth explaining Greatest Common Factors and Least Common Multiples to our fifth child, Jonathan.

When I was a kid, I was kind of a prodigy with math (I am not so now), and when we went through it in school, I remember tutoring my classmates on the two topics. I always thought the two concepts were related, but I never understood how, until it struck me last week.

Consider the numbers 60 and 144. What are their Greatest Common Factors and Least Common Multiples? To start, let’s factor the two numbers:

Then, let’s place the common factors in the intersection set.

The greatest common factor is the product in the intersection set, in this case, 3x2x2 = 12. The product of the union set (just multiply across) is the least common multiple — 5x3x2x2x3x2x2 = 720.

When I realized this, I drew it out for Ruth and Jonathan, and told them “Look at the ravings of a madman.” But later that evening, Ruth came to me and thanked me for it, because it worked with Jon, and clarified it to her.

As a mathematician, I am nothing great, but my intuition has been a great help to me at many points. This was one of them.

Update Saturday Afternoon

As F comments, “Which has the consequence that LCM*GCM = number1*number2.”

I should have written that myself, but didn’t.? Thanks for pointing that out.? It is an application of the rule that:

set A + set B = union of A&B + intersection of A&B

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